Transcript

Michel Barnier [archival]: (Translated from French) This moment is absolutely decisive for the governance of the euro zone and for Europe itself. It is surely not the moment to express pessimism, or doom-monger. It is a moment for great determination by all the European leaders.

Keri Phillips: EU commissioner, Michel Barnier, speaking after a meeting with Mario Monti, the economist who was installed as prime minister of Italy last month. Only time will tell if the latest proposal by French and German leaders, announced on Monday, to create a new treaty will actually bring to an end the sovereign debt crisis in the euro zone.

Keri Phillips here on ABC Radio National with Rear Vision, where today we’ll try to work out just why the last 22 months of meetings, announcements, bailouts and austerity packages failed to find a solution.

Essentially the mechanics that set the whole thing off are pretty straightforward. Although the particulars for each country are different, many, hit first by the global financial crisis in 2008 and then caught up in the economic stagnation that’s followed, got deeper and deeper into debt. Once investors—banks, pension funds, insurance companies and so on—decide a country can’t make its repayments, they stop buying its government bonds, except at high rates of interest. Set this going in the euro zone, where there are 17 different governments with different views on what should be done and who should suffer the resulting financial pain, and you have the setting for the following story.

It all began in late 2009, when investors started to worry that the Greek government might not be able to meet its debt repayments.

Charles Wyplosz is Professor of International Economics and Director of the International Centre for Money and Banking Studies at the Graduate Institute of International Studies in Geneva. When I spoke to him on Skype, I asked him why Greece, which represents only two and a half per cent of the euro zone economy, became a headache for all the other members.

Charles Wyplosz: Your question about why Greece became a European problem is an excellent question. It is, in fact, the question. We had in the treaties a so-called no bailout rule that says that no government and no central bank is allowed to support a fellow government that is running into trouble.

Now, when the market started to worry about Greece, if the policymakers had followed the treaty they would have told the Greek government, ‘We are very sorry for you. We can’t do anything. You go to the IMF and you deal with them.’ But they didn’t and it said ‘We’re all brothers and sisters in the euro zone, we are not Latin Americans, we don’t default over here and we are going to bail out Greece.’

This decision made the Greek debt problem a European debt problem and it’s the mother of the crisis that followed.

Keri Phillips: Benedicta Marzinotto is a research fellow at Bruegel, an independent European think tank in Brussels.

Benedicta Marzinotto: You’re very right in saying that the Greek debt problem became a euro zone problem and I would say unnecessarily, because Greece had its dramatic fiscal situation; since the very beginning it was almost clear that Greece was insolvent. And the policymakers refused to go for an orderly default in the case of Greece, to accept the fact that Greece was insolvent.

And I think there are two main reasons why. And the first one is that they didn’t want to send a wrong signal to other countries, they feared that all other countries—especially Italy and Spain—would misbehave fiscally so they had to rescue those two countries just after Greece. And that’s the main reason. It’s the ‘moral hazard’ argument. And the second reason was that also the Greek banking system is very much exposed to Greek debt, so they needed to make sure that this default would not translate into a huge economic recession for Greece and a credit crunch and so on and so forth. So there was this issue, also, of what to do with the Greek banking system that delayed actions.

Journalist [archival]: Describing his country’s economy as ‘a sinking ship’, the Greek prime minister made a formal request for an international bailout, becoming the first member of the European Union to do so.

Giorgios Papandreou [archival]: (Translated from Greek) It is necessary. It is a national and imperative need to officially request from our partners the activation of the support mechanism which we created in common with the European Union.

Journalist [archival]: The plan was arranged two weeks ago in Brussels. It provides for loans of up to $60 billion from euro zone partners as well as $30 billion from the International Monetary Fund.

Charles Wyplosz: What they did next was to quickly build up a rescue package for Greece. In the end they had to accept that Greece goes to the IMF, against their will, then they had to build a big rescue package. The next thing they did was to build another fund, which is called the EFSF, the European Financial Stability Facility—a sort of euro zone IMF—to scare the markets if they ever thought about contagion. And this EFSF was meant to be a China wall against any attempt by the markets to go after another country. And of course the markets jumped over the wall in no time.

Keri Phillips: To get the loan, Greece had to agree to cut public spending and raise taxes as a way of reducing its debt. Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley.

Barry Eichengreen: What happened, not exactly to the surprise of outside economists, was that the more the Greek government cut public spending, the deeper the recession in Greece became. There was uncertainty about whether the approach would work, so firms didn’t invest, households didn’t spend, and meanwhile the government was cutting its spending and desperately trying to raise new taxes. That was a recipe for recession and in a recession, tax revenue falls, some forms of government spending on unemployment insurance, on police in the streets, inevitably rise. So the measures that officials hoped would work to cut the budget deficit and begin to reduce the debt had exactly the opposite effect.

Keri Phillips: And despite the fact that the EFSF guaranteed to lend to any other euro zone member who had trouble raising money on the bond market to keep up with debt, it actually made things worse. Janis Emmanouilidis is a senior policy analyst at the European Policy Centre in Brussels.

Janis Emmanouilidis: Because it was not only a Greek problem. It is a problem which has extended far beyond Greece. First it reached Ireland and then it reached Portugal—both countries had to also seek help from their peers in the euro zone, from other euro zone countries. There was a European Financial Stability Facility set up, a rescue mechanism set up by all euro zone countries, from which Ireland and Portugal also received help. But as time progressed, even extended beyond Greece, Ireland and Portugal; lately we’re also seeing the credit costs of core euro zone members, who up to now were doing rather well, increasing.

Keri Phillips: Why has that happened?

Janis Emmanouilidis: Well, because people who would lend, or institutions who would lend these countries moneys, don’t trust that these countries would be able to pay back, or they argue that the risk of them not paying back is higher than it is in the case, for example, of countries like Germany or Luxemburg. So if you look into the roots of the crisis, it has to do a lot with a crisis of trust or distrust. There’s a distrust that these countries will be able to deliver when it comes to their sovereign debt, that these countries will return to growth, because that is always something which is accounted for by the international financial markets. You have to look at every case individually, but the basic problem is this problem of trust or distrust.

Barry Eichengreen: The problems in Greece made investors uncertain. There was no clean resolution to Greece’s problem. People began to wonder about whether Portugal and Spain and Italy might be headed down the same path. All of these countries are heavily indebted and they can pay back what they borrowed in the past only if they can grow their economies.

So the bad news in the third quarter of this year is that economic growth in Europe basically stopped. Government spending cuts and the policies of austerity across the continent, combined with no support for economic growth from the European Central Bank, meant that European economies stopped growing and everyone began to expect another recession coming now.

So under those circumstances, no one was prepared to buy Italian bonds, to buy Spanish bonds, to buy Portuguese bonds. These countries found it impossible to raise more money except at exorbitant interest rates. Where they had been able to borrow for ten years at two per cent or so as late as 2009, they are now borrowing—depending on the country you’re talking about—at seven, eight, nine, in some cases 15 per cent.

Keri Phillips: And the institutions or people who normally lend to governments by buying their bonds, they’ve obviously made a judgement that these countries would have difficulty, or would find it impossible, to repay.

Barry Eichengreen: If their banks, the banks understand that they have very little margin for error—European banks are very highly leveraged, they have very little capital, very little of their own funds. In the case of insurance companies and pension funds, their portfolio managers want to invest in safe assets. They realise that they have pensioners who are going to be owed a monthly payment. Insurance companies have policies; they’re going to have to pay out on their life insurance policies, so they want safe assets that have the same term to maturity, that run to the same length of time, as their own financial obligations.

So the realisation now is that European sovereign bonds are not safe and the appetite for them from pension funds and insurance companies is no longer there. You know, financial markets just react to events, and if you want to point a finger, I would point a finger at the politicians whose response to the crisis has been somewhere between inept and perverse.

Keri Phillips: What about the European Financial Stability Facility? Surely that would guarantee debts of all euro zone countries in the way it had guaranteed the Greek debt.

Charles Wyplosz: They were able to put together a package of €750 billion. They thought that the markets would just be scared by this €750 billion announcement. If you look at the size of the public debts of the European countries, you get to €10,000 billion, so that their humungous package was a tiny fraction of the amount of public debt that exists. And once they said we’d guarantee all public debts of all of us, they just didn’t have the firepower to impress the markets.

Keri Phillips: But presumably not many countries were in the situation that Greece was in where it genuinely couldn’t keep on paying its debts.

Charles Wyplosz: No, but what they did then was to start a real domino game, whereby all countries but Greece would guarantee Greece; when the next shoe fell, it was Ireland, all countries but Greece and Ireland would guarantee Greece and Ireland; and then Portugal and—you see me coming—at the end of the day we have Germany to guarantee everybody else and Germany can’t guarantee a debt that’s several times its GDP.

One important part of the story that I didn’t mention yet is that if Greece, the first country to shake, were to default on a significant part of its debt, that would hurt the creditors of Greece, and chiefly among them you have French banks and German banks. And we can go on with Ireland and Portugal and now Spain, and the big number is Italy, because Italy is a large country and its debt is very large. And if Italy defaults significantly you can kiss goodbye to a big chunk of the French and German banking systems. And if the French and German banking systems fail, the French and German governments have to bail them out as well.

So we’re not talking about bailing out tiny little Greece, with its tiny little debt, we’re talking about bailing out the huge debt of Italy and then bailing out the banks at the core of the system.

Charles Wyplosz: Two hundred per cent. First, the management of the crisis has been taken over by the German chancellor, Angela Merkel, and by the French president, Nikolas Sarkozy. We haven’t heard any single word from the European Commission and the other countries have reluctantly accepted this leadership.

There is no doubt in my mind that the gut reaction of Merkel and Sarkozy when Greece started to tank was, ‘Oh no, we don’t want to go to another bank restructuring. We did one last year after Lehman Brothers and our voters were furious.’ People were absolutely outraged, not just in Europe, everywhere in the world, about the need to pour billions into banks whose bankers were paying themselves these huge bonuses.

So their immediate reaction was political: ‘We can’t take any risks with our banks, so we’ll stop the rot in Greece.’ That’s been the same process all along. Politics has totally dominated. There has been no understanding of the way a crisis develops and propagates itself. They were trying to solve yesterday’s problem, totally ignoring that the problem is going to get worse tomorrow.

Keri Phillips: In the end, at the end of October, Greece defaulted on its debt anyway.

Mark Colvin, PM [archival]: After hours of tense negotiations in the early morning Brussels-time, the leaders emerged with an agreement that banks would write off 50 per cent of their Greek debt holdings.

Nicholas Sarkozy [archival]: (Translated from French) The International Monetary Fund, the European Central Bank, the Commission, say that the Greek debt is sustainable, so long as we bring it down to 120 per cent of the Gross National Product by 2020.

Keri Phillips: This is Rear Vision with Keri Phillips on ABC Radio National and Radio Australia. Don’t forget you can listen to this program again whenever you like, organise a regular podcast, or read a transcript at our website. And you can follow us on Twitter by searching for RNRearVision. Today we’re trying to make sense of the euro zone sovereign debt crisis.

European leaders announced a €106 billion recapitalisation of Europe’s banks and a plan to increase the lending capacity of the European Financial Stability Facility by about one trillion euros—without increasing the amount of money being put in by European governments. But the announcement got the thumbs down from the markets, which drove the yield on Italian debt— the interest rate the government would have to pay—into the danger zone: over seven per cent. Despite the austerity measures brought in in September, Prime Minister Silvio Berlusconi was replaced in mid-November by a former European commissioner, Mario Monti, who announced a cabinet of technocrats and academics to help steer Italy through the financial reefs ahead.

Looking back from the current desperate situation, what should the euro zone leaders have done?

Benedicta Marzinotto: I think it would have been much easier at the very beginning of the crisis, so in May 2010, to indeed assess the Greek situation, conclude that Greece was insolvent, and forgive part of the debt. It’s also important that at the same time when they were doing so, they should have thought of a very convincing communication strategy where financial markets wouldn’t think that the same thing would happen to other countries.

So they could have rescued Greece at the very beginning. It would have been much less costly than the situation we’re in now, which is extremely costly if you think that one prospect is the breakup of the euro. But it’s also true that they would have had to make a huge effort in communicating this decision to markets, and unfortunately there are so many political divisions in Europe and political conflicts about what needs to be done, that it’s very difficult to imagine that given the lack of political consensus, you are able to produce an external communication strategy that is efficient and that is persuasive enough in the eyes of financial markets.

Janis Emmanouilidis: Well, I think that after 20, 22 months, one can say that if in the initial phase of the crisis, when it was still a Greek crisis, they would have sent out a strong signal to the markets arguing that, ‘We will support the Greeks, whatever comes. We will provide them liquidity in case they have liquidity problems, we will find solutions to the Greek problem,’ if that would have happened, then I think the risk of the crisis spreading would have been much lower.

However, at the time it was considered that this was only a Greek crisis and even if it would extend to other member states, at some stage it would stop. Nobody was thinking that it would at some stage be able to reach the core of the euro zone and even threaten the stability of the euro zone. And those who saw it coming earlier, at that time, were very few and they were not heard as much as those who were arguing, ‘We now have to find ways of solving the Greek crisis, the Irish, the Portuguese, individually.’

Keri Phillips: Would that kind of approach have involved the European Central Bank in effect doing what the reserve banks in the UK and the US have done for different reasons, in effect printing money to maintain liquidity within the euro system?

Janis Emmanouilidis: In the initial phase of the crisis, I don’t think that that was the key. The key would have been for other euro zone countries to provide a clear sign to the markets that they would be ready to support these countries who were in need. So it was not the ECB which was playing the central role. Now that we’ve reached a level of the crisis which is much worse, much higher, the crisis recipes which now remain involve also the European Central Bank, but also the eventual creation of European bonds, euro bonds, or stability bonds as they are now called, which would be guaranteed by all member states.

So we’ve reached a point in the crisis where you have to come up with much bigger forceful reactions than you would have had to do in the first, initial phase of the crisis. And that involves also the ECB but not only.

Keri Phillips: The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 euro zone member states. Although similar to other central banks, like our Reserve, its main role is to keep inflation low within the euro zone. Since the crisis began in Greece, the European Central Bank has stepped up its buying of member nations’ debt, but obviously not enough. Since the global financial crisis of 2008, countries like the US and the UK have used their central banks to keep money flowing into their economies by what is called quantitative easing—crudely, printing money. Some have argued that this is what the ECB should have done.

Benedicta Marzinotto: I think in the current situation, where we have moved from a possible solvency problem in Greece and suspects about the solvency problem in Italy, we are now as financial markets have started attacking countries like Austria and Netherlands, we are fully in a liquidity crisis, which in my view—but this is a very contentious issue—would call for a much stronger role of the ECB, since the ECB is not concerned with solvency and with saving a government, but is concerned with the state of liquidity in the European financial markets.

Keri Phillips: So what do you think the ECB should do?

Benedicta Marzinotto: I think the ECB should intervene massively and provide the liquidity that both governments and now also banks need.

Keri Phillips: So print money.

Benedicta Marzinotto: Yes, if you want to put it that way, yes.

Keri Phillips: This is a path that has been strongly resisted by Germany, which recalls the hyperinflation in the Weimar Republic in the early 1920s, when the government tried to get itself out of a financial hole by printing money, causing the currency to lose its value at a terrifying rate. In 1922, a loaf of bread cost 163 marks. By the end of 1923, a loaf of bread cost 200 billion.

Charles Wyplosz: If you’re raised in Germany, you’re told from the very beginning that Central Bank paying for the budget deficit is leading to Hitler and the war and all of that. That’s why the gut reaction of the Germans is that the ECB should not be doing the big job in stopping the crisis. Unfortunately this is completely wrong and that’s why I was telling you a bit earlier, one has to be delicate looking at the past and looking forward.

Backstopping the existing public debt is very, very different from financing the budget deficit as we move ahead. So I don’t think the ECB should be financing budget deficits as we move ahead, because that is the source of inflation, possibly hyperinflation, but going backward and backstopping the existing stock of debt is not going to be inflationary. You mentioned correctly that the Bank of England and the Fed are buying vast amounts of public debt and there is no threat of inflation; if anything we worry about deflation. So that there is a deep economic reasoning mistake that’s dominating in Germany right now and that is what is blocking the rapid resolution of the crisis.

Mario Draghi [archival]: Companies, markets and the citizens of Europe expect policymakers to act decisively to resolve the crisis. It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union.

Keri Phillips: Mario Draghi, head of the European Central Bank, speaking late last week. At a time of growing distrust and resentment among euro zone members, and as the crisis reaches the final phase, what are the choices?

Janis Emmanouilidis: We’ve reached that point in time where you have to come up with much bolder reactions involving the European Central Bank putting into place eventually European bonds which are collateralised; i.e., every euro zone country guarantees for it. And extending also the European Union, or deepening the European Union, especially the euro zone, towards in the direction of a fiscal union, or you might even call it a political union eventually.

So you need a more, a higher level of integration in Europe in order to counter the balance; monetary union with an economic union. So that package is what needs to be brought in place. This is very difficult because it involves a loss of sovereignty for member states, especially in the euro zone, so it’s difficult to find an agreement on these issues, but I think we’ve reached the point in time at which only if you come up with these kind of bold decisions will you be able to stop the crisis from growing in a way that it might even become Europe’s Armageddon.

Philip Williams, AM [archival]: At the centre of this storm, Germany and France. And it was the leaders of these pivotal countries that met in Paris a few hours ago and pushed for a new treaty:

Nicholas Sarkozy [archival]: (Translated from French) Our desire is to go on a forced march and re-establish confidence in the euro. We have no time left. We are well aware of the seriousness of the situation and the responsibility that sits on our shoulders. We have to act as quickly as possible.

Keri Phillips: Proposals announced on Monday call for a new treaty that ensures that euro zone states face greater checks on their budgets and sanctions if they run up deficits, although at this stage Germany is opposed to the idea of euro bonds. In setting up the common currency a decade ago, it was agreed that governments in individual countries could keep control of raising money and spending it. Although members were supposed to ensure that their debt never exceeded 60 per cent of their GDP, everyone ignored that, leading to the current mess. In order for the euro zone now to survive, it seems that giving up sovereign control over the budget will be the price.

Barry Eichengreen: It will have to. Indeed, the idea that monetary union would lead with the passage of time to fiscal union, a common European budget and to political union, or deeper political integration—a more powerful European parliament to oversee the European budget—that was the idea from the beginning. But the architects of the euro thought they had decades to complement their monetary union with a fiscal union and political union. They didn’t figure with the most serious financial crisis since the great depression; that sideswiped them in 2009. And all of a sudden they now have two weeks to complete their plans for fiscal and political integration, not two decades.

It’s already affecting the US economy, the Asian economy—China’s exports to Europe have fallen off a cliff, so your exports to China are going to feel that as well. But while this big mess is already affecting all of us, the collapse of the euro would be a very much bigger mess and, again, very much bigger than the financial crisis we saw in 2008–2009.

Keri Phillips: On Rear Vision today, we heard Professor Charles Wyplosz from the Graduate Institute of International Studies in Geneva, Benedicta Marzinotto from Bruegel, an independent think tank in Brussels, Professor Barry Eichengreen, from the University of California, Berkeley and Janis Emmanouilidis from the European Policy Centre in Brussels.

Leila Shunnar is the sound engineer for Rear Vision. Goodbye from Keri Phillips.

Guests

Charles Wyplosz

Professor of International Economics and Director of the International Centre for Money and Banking Studies, Graduate Institute of International Studies, Geneva

Benedicta Marzinotto

Research Fellow, Bruegel, an independent think tank,Brussels

Barry Eichengreen

Professor of Economics and Political Science, University of California, Berkeley

Credits

Comments (1)

Siobhan Holmes :

Thank you so much for the excellent, understandable explanation of the European Debt Crisis.

It is the first time I have heard a clear, explicit account of how we got into the mess we are in.

I'd LOVE to hear what the author thinks can be done to bring some sense to the world economy.

My small contribution, is that nothing CAN be done - until the world stops aiming at exponential growth as a necessary goal. Grow up, the world as we know it is disintegrating on many fronts. Aiming for sustainability in all things, seems to me, the only way to go.